An Economic Defense of Flexibility in IPR Licensing: Contracting Around 'First Sale' in Multilevel Production Settings

Abstract

The legal doctrine of first sale (or exhaustion for patents) dictates that the first sale of any good (intermediate or final) that embodies licensed IPR exhausts the holder’s rights. Thus, a patent holder is held to licensing just one party in a good’s production chain and an original copyright holder cannot affect the resale of a copyrighted good. The Supreme Court’s decision in the Quanta case strengthened the patent exhaustion rule, but the ruling appears to leave open the possibility that the parties could contract around patent exhaustion. In this paper, I present an economic argument in support of such contractual flexibility in situations involving intermediate production goods. In particular, I argue that under several real world circumstances the ability to license more than one party in a vertical production process makes economic sense and does not result in anticompetitive harm. Concerns such as "double dipping," raised during Quanta, do not hinge on multi-level licensing. Thus, as long as the parties involved can be presumed to understand the terms and conditions, they should be free to contract around a default "first sale" rule.